Economics Chapter 14 Flashcards
MARKET FAILURE
Market failure occurs when markets are inefficient. Market failure occurs when the free market fails to allocate scare resources at a socially optimum level of output.
Socially optimum level of output: The level of output where social costs equals social benefit and society’s welfare is maximized.
CAUSES OF MARKET FAILURE
- Positive and negative externalities
- Under-provision of public goods and merit goods
- Over-provision of demerit goods
- Abuse of monopoly power
- Income inequality
- Factor immobility - occupational and geographical
EXTERNALTIES 1
Positive and or negative side-effects on a third part who were not involved in the economic decision making, and whose interests are not taken into consideration.
There are positive and negative externalities in both production and consumption of goods.
Production externalities: Positive and negative side-effects on a third party caused from the firms production process. It is normally due to the profit motive and the fact that firms will overlook negative externalities in order to minimize their costs.
Consumption externalities: Positive and negative side-effects on a third party caused from people consuming goods.
EXTERNALITIES 2
Private benefit: is the benefit derived exclusively by the producer and/or consumer
Social benefit: is all the benefit derived from the use of a good, including benefits to the producer, consumer as well as rest of society
External benefit: is the benefit derived from use of a good by a third party
Private cost: is the costs of a good incurred solely by the producer and/or consumer
Social cost: is all the cost incurred from the production or use of a good, including costs to the producers, consumers as well as the rest of society
External cost: is the costs of a good incurred by a third party
where no externalities exist:
- social benefits = private benefits
- social costs = private costs
where externalities exist:
- social benefits = private benefits + external benefits
- social costs = private costs + external costs
SOCIAL COST > SOCIAL BENEFIT = MARKET FAILURE
⇓
uneconomic use of resources
INFORMATION FAILURE
In order to perform efficiently, all sections of the economy should have access to the information they need:
WORKERS CONSUMERS PRODUCERS
UNDERPROVISION OF PUBLIC AND MERIT GOODS
Producing little of:
Merit goods: goods that are desirable for consumers, but are underprovided by market. Merit goods are underproduced and under-consumed because of consumer ignorance, because of poverty, and because the market ignores positive externalities.
Public goods: are extreme examples of merit goods that are non-rivalrous, non-excludable, non-rejectable and often the cost is zero
DEMERIT GOODS
Products which the government considers consumers do not fully appreciate how harmful they are and so which will be over-consumed if left to market forces. Such goods generate negative externalities.
PRIVATE GOODS
Most products including merit and demerit goods are private goods. Private goods are:
- Rivalrous
- Excludable
- Possible to stop non payers from enjoying the product
- Usually have a cost for one person also.
ABUSE OF MONOPOLY
A monopoly is when there is a single or dominant firm in a market that has significant market power to set price. Monopolies underproduce and sell their products at high prices. They resort to price fixing. In addition, they tend to be inefficient and fail to innovate due to a lack of competition.
Price fixing: when two or more firms agree to sell a product at the same price
INCOME INEQUALITY
Not everyone in an economy earns the same income. As a result, they don’t all have the same access to goods and services.
For example, very low-income earners may be prevented from consuming merit goods such as education and healthcare.
IMMOBILITY OF RESOURCES
It is required to move resources from an industry where demand is decreasing to one for which the demand is rising. It may not be possible due to:
- Occupational immobility - Example- A cashier cannot replace a steel worker.
- Geographical immobility - Example- movement of fixed plants is not possible, workers may not move due to living costs or family ties.
As a result markets are characterized by misallocation of resources.
SHORT-TERMISM
Producers and consumers are guided by demand for consumer goods. Market forces may not devote sufficient resources to capital goods. The short sighted approach may result in lack of investment.
